Sources of Finance
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Transcript of Sources of Finance
Homework time
• I gave you homework to complete your budget tasks.
• I want to collect that now.
• So have them on your desk now and ready to hand in. If this takes more than 2 minutes I’ll be annoyed
So what's up budgets?
Sources of finance Business Unit 1
Why do firms need finance?
– To expand– To buy new equipment– To start up a new business– To pay workers– To buy premises– To survive– To buy stock– To cover a fall in demand (recession)
Sources of Finance
Sources of Finance can be either:
Internal External
Internal can be cheaper, but spending this money on the
business means the money can’t be spent on other projects like
investing
Comes from outside the business. This
usually costs more as interest may be
charged
Types of Finance
• Internal – Personal savings– Retained profit–Working capital (money in the
till)
– Sale of assets–Debt Factoring
Types of Finance
• External – Shares capital –Debentures (secured loan)
–Mortgage (secured loan)
–Other loans–Overdraft facilities–Hire purchase / leasing– Trade credit– Venture Capital – Grants
How much finance can a business get?
• It depends on risk assessment based on:
– The type of business
– Stage of development
– State of the economy
Choosing the right type of finance is based on
How long the money is needed for
• The duration of the loan should reflect the time they expect to need the purchase for– You would not take a
5 year loan for a van that you expect to last 3 years
The legal structure of the business
• A sole trader can’t sell shares
• The liability of the owners must also be taken into account
Liability
Unlimited Limited– The owners of the
business are personally liable for any debts which the business may have (Can be risky)
Limited Liability– The liability of the
owners (the shareholders) to pay off debts is limited to the amount of money which they have invested in the business (Safer)
Time Periods for Finance
Finance is generally considered to be either:
Short-term Short/Medium Long-term
1 year 2 to 5 years Over 5 years
Borrowing Money
Time
frame
Possible
usage
Short term 1 year Working capital, raw materials
Short (medium)
term
1 – 5 years Capital expenditure (vehicles,
refurbishments etc)
Long term Over 5 years
Major capital expenditure
(buildings, lands etc)
Types of finance• Long term finance
– Normally for large projects like expanding, research or producing a new product.
– Often less interest to pay back on this type of finance
• Short term finance
– Often used to fill gaps in the cash flow of a business, like paying rent.
– Often flexible and comes at a higher rate of interest
Long Term Finance (5 – 25 years)
• Share capital (PLC & LTD only)
• Shares are sold by the business to raise capital. In a PLC this is done on the London Stock Exchange, LTD you must know the seller, the profit share they get is called a dividend
• Venture Capital (PLC & LTD only)
• Someone will buy shares in the business to help them grow faster and sell them at a profit (Dragons Den)
Long Term Finance (5 – 25 years)
• Debentures (PLC & LTD only)
• Is a secured loan. Interest is paid to each holder, this is paid before any money is paid to share holders
• Mortgages• Is secured a contract that means the loan is secured on property and that the party buying it will not own the property till its fully paid
Long Term Finance (5 – 25 years)
• Loans (this can be a short term source too)
• Normally given out by the bank, will have to repay over a set number of years with interest, paid at the same time every month
• Retained Profit• Profit the business has made and is reinvesting in the business, this is often used to buy stock, and pay wages on a weekly basis
Long Term Finance (5 – 25 years)
• Grants• This is money given to the firm by the government, this money does not have to be repaid
Short Term Finance (up to 5 years)
• Leasing equipment • Will allow you to rent out equipment
over time instead of buying it, useful if you only need equipment for a short time, but you never own it
• Hire Purchase• Like leasing but you pay every month
for the product / equipment, instead of paying in one go, it means you don’t have to spend a large amount at once, and you keep it after
Short Term Finance (up to 5 years)
• Bank overdrafts • is a negative balance that the bank
allows you to use in emergencies, this is repaid when money goes in to your account, high interest but flexible
• Trade credit• is an amount of time that firms give
you to repay them for items they have sold you (normally 30 days)
Short Term Finance (up to 5 years)
• Factoring• A factoring firm will buy a firms debts
and assume the risk on non-payment. The factor collects the debts directly from the businesses customers. (But pays less for the debt than owed)
Question Time
• All students must have one question !!
• Write 3 down in case somebody else asks it.What’s Business
Homework Time
Sources of business finance
Owner’s fundsExplanation Benefits Drawbacks
Money put into the business by the owner
No need to pay interest on the money
Could have been invested elsewhere, earning a higher profit
Owner may not have enough funds to meet the needs of the business
Retained ProfitExplanation Benefits Drawbacks
Money kept in the business by the owners
Known as retained profit on the balance sheet
No need to pay interest on the money
Could have been invested elsewhere, earning a higher profit
The business may not have enough retained profit to meet its needs
Shareholders may become unhappy if this means lower dividend payments
Selling AssetsExplanation Benefits Drawbacks
Items owned by the business are sold and the money made used to finance the business
The business is using money it already has – so no need to take on loans or pay any interest or charges
The business has to have something worth selling for this to be an option
The business may sell something they later need
OverdraftExplanation Benefits Drawbacks
The bank allows the business to draw more money from their bank account than they actually have in it
Very quick to arrange
A good short term solution to a cash flow problem
Only suitable for smaller amounts and has to be repaid within a short amount of time
Interest or charges are paid
Trade CreditExplanation Benefits Drawbacks
Items are bought from suppliers on a ‘buy now pay later’ basis
Gives the business more cash to use in the immediate future
Can only be used to buy certain goods
Bills usually have to be settled within 30,60 or 90 days, usually 30!
Debt FactoringExplanation Benefits Drawbacks
The company sells a debt it is owed to a debt factoring company who pay the business a smaller sum than they were owed
Allows the business to get money for debts that might otherwise never have been paid
Saves the business time chasing customers etc for money owed
Time consuming to arrange
The business receives less money than it was originally owed – this may affect profitability
LeasingExplanation Benefits Drawbacks
Used to help obtain new equipment eg cars
The business rents the item from its owner
Cost of the asset is spread over its life
No need to find a lump-sum of money to purchase it
May be more expensive than buying the asset – the owner will want to profit from the deal
The business does not own the asset so it does not appear on the balance sheet
Debentures Explanation Benefits Drawbacks
Long term borrowing similar to selling shares, but with the promise of repaying the amount lent at a fixed period in time, usually for a set amount of interest
A very structured method which allows the business to know exactly how much interest will be paid and when the debt has to be paid back
Usually ‘secured’ onto assets of the business such as property, therefore if the interest on the debt, or the debt itself isn’t repaid, the debenture holder will claim the item/property
No longer a popular method of finance for businesses
Bank loanExplanation Benefits Drawbacks
An amount of money is borrowed from the bank, then repaid (with interest) over a set period of time
Easy and quick to set up
Large amounts of money can be borrowed
Structured repayment term
Interest payable If repayments
cannot be kept up, the business risks getting a poor credit rating or being made bankrupt
Issuing SharesExplanation Benefits Drawbacks
A share in the business is sold to an individual or another business. This money then used to purchase new assets
No need to repay the money invested
Cheaper than a loan.
Some businesses can raise large sums of money this way
Need to pay the shareholders a share of future profits
Ownership also means some influence over how the business is run – the original owners may lose control of the business
Risky for the shareholder - the investment may be lost if the business fails
Mortgage Explanation Benefits Drawbacks
Long term loan provided by a bank in order to buy property
Only method available to buy property
Structured repayments over a long term (25 years)
Large sums of interest charged
Can take a long time to repay debt
Government GrantExplanation Benefits Drawbacks
Money given to the business by the government.
Used to help finance new projects – especially those that create new jobs
No need to repay the grant
Limited funds are available
May be restrictions on what the money can be used for
Hire Purchase Explanation Benefits Drawbacks
An item is bought on finance, repayments are made each month until the final payment when the item becomes the property of the firm
Flexible method – can hand back the item if no longer required and payment will stop
High interest often charged
Item doesn’t belong to the business until the end of the term
Venture CapitalExplanation Benefits Drawbacks
Venture capitalists invest in small, risky business e.g. new business start-ups
Can raise money from them even when banks have refused to lend to the business
Risky for the venture capitalist
The VC may want to have some control over how the business operates